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How Much Money Do I Need to Spend on Advertising?

Q: I've never really done much advertising for my business;
I've always relied on networking and word-of-mouth. Now I'd like
to launch a small campaign, but I'm frightened it will cost a lot
of money. How can I figure out where to start?

A: The first thing you must do is calculate your minimum and
maximum allowable ad budgets:

· Step 1: Take 10 percent and 12 percent of your
projected annual, gross sales and multiply each by the markup
made on your average transaction. In this first step, it's
important to remember that we're talking about gross markup here,
not margin. Markup is gross profit above cost, expressed as a
percentage of cost. Margin is gross profit expressed as a
percentage of the selling price. Sell an item for $150 when it
only costs you $100, and your markup is 50 percent. Your margin,
however, is only 33.3 percent. This is because the same $50 gross
profit represents 50 percent of your cost (markup,) but only 33.3
percent of the selling price (margin.) Most retail stores in
America (carpet, jewelry and so on) operate on an average markup
of approximately 100 percent, some operate on as little as 50
percent markup and others add as much as 200. More expensive
items, such as cars, recreational vehicles and houses, typically
carry a markup of only 10 to 15 percent.

· Step 3: The remaining balances represent your minimum
and maximum allowable ad budgets for the year. At this point in
the calculation, you may learn that you've already spent your ad
budget on expensive rent, or you might also learn that you should
be doing a lot more advertising than you had previously
suspected.

Now let's calculate an ad budget. Assume that my business is
projected to do $1 million in sales this year, I have a profit
margin of 48 percent, and my rent is $36,000 per year. The first
thing to do is calculate 10 percent of sales and 12 percent of
sales ($100,000 and $120,000, respectively).

Second, we must convert my 48 percent profit margin into
markup, because markup is what we've got to have to make this
formula work. Most business owners know their margin by heart,
but never their markup. To make the conversion from margin to
markup, simply divide gross profits by cost. Dividing $480,000
(gross profits) by $520,000 (hard cost) shows us that a 48
percent margin represents a markup of 92.3 percent. Bingo.

Now we multiply $100,000 times 92.3 percent to see that our
adjusted low budget for total cost of exposure is $92,300.
Likewise, we multiply $120,000 times 92.3 percent to get an
adjusted high budget for total cost of exposure of $110,760. From
each of these two budgets, we must now deduct our $36,000 rent.
This leaves us with a correctly calculated ad budget that ranges
from $56,300 on the low side to a maximum of $74,760 on the high
side.

Most advertising salespeople will tell you that "5 to 7
percent of gross sales" is the correct amount to budget for
advertising, but don't you believe it. It simply isn't possible
to designate a percentage of gross sales for advertising without
taking into consideration the markup on your average sale and
your rent. Yes, expensive rent for a high-visibility location is
often the best advertising your money can buy, since a business
with a good sign in a high-visibility location will need to
advertise significantly less than a similar business in an
affordable location.

To prove this, just look at the example above and change the
rent to $75,000 per year. In this case, the ad budget would range
from $17,300 to $35,760, representing just 1.7 to 3.5 percent of
sales. The formula I've given you is the only one that reconciles
your ad budget with your rent as well as the profitability of
your average sale. Good luck!

Steve Moundzouris, 423-653-2201 BigWater Media Group, Bigwater
Media Group is a full service advertising and marketing
agency.

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